Friday, August 04, 2006

Life without credit: tough and expensive

These days, your credit history can affect everything from insurance coverage to your job application. Here is why it hurts to lack credit, plus some tips for breaking in.

What do you need to get a loan or credit card? A good credit history, of course.

And how do you get a good credit history? By getting a loan or a credit card and paying on time.

Sometimes life can seem like a giant Catch-22, and that’s especially true when it comes to credit, says Maxine Sweet, vice president of public education for Experian, one of the three major credit bureaus. “If you don’t have credit, you can’t get credit,” she says.

Pretty much like the vicious circle of employment: You can’t get a job without experience and you can’t get experience without a job.

But, Sweet explains, you can work your way into the traditional credit system and some lenders will work with you.

There are 20 to 25 million people in the U.S. living without any credit, according to figures from Fair Isaac Corp., the company that pioneered credit scoring. In addition, another 30 million to 35 million have “very little credit on record,” says Craig Watts, public affairs manager for the company.

That’s as many as 60 million people — close to one-fifth of the population — who will have trouble accessing traditional credit.

At the same time, more businesses are looking at credit histories and credit scores. Many insurance companies and employers routinely check credit. So do mortgage and auto lenders. And, these days, apartment complexes and utilities often run checks before accepting new customers.

The young and the newly arrivedSo who is living outside the credit system? It’s hard to say because attempts to classify them haven’t been that successful, says Watts. “The data doesn’t match up,” says Watts. In other words, the financial-services industry is having a tough time getting a handle on exactly who is outside the system because they are outside the system.

But credit industry experts agree there are two main groups that comprise the largest segments of the group: the very young (particularly those who have not gone to college) and the immigrant population.

College students are usually bombarded with credit card offers. They often have little or no credit history, yet lenders see them as a decent risk because once they graduate they will likely have strong earning power. But lenders will typically offer them a low line of credit and a very high interest rate.

However, those who don’t attend college could find themselves left out of the credit offers and in danger of falling into the little- or no-credit-history category.

The second vulnerable group is the immigrant population. That’s because credit histories can’t cross international borders. So if you live in Montreal with spotless credit and decide to move to Miami, you’re starting from scratch with no credit history. “The U.S. is not synched up with other international systems,” says Watts.

And there are several other groups that may fall into the no- or low-credit history category:

Retirees. If they’ve gone a long time without using a credit card and the mortgage is paid off, they may have little or no credit history, says Watts.Older widows and divorcees. If a couple routinely kept the mortgage, bills and credit cards in the husband’s name and he dies or leaves, the woman is starting with a blank slate. But this situation is much less common than it was 30 years ago, according to credit experts. “Most people know to have both names on the account, so that it appears on her history,” says Sweet.

Those who purposely abstain from seeking credit. For some people, the decision to live without credit is voluntary and not an accident or matter of temporary circumstance. “They might have philosophical, political or religious reasons” for living a cash-only life, says Watts.

Those who have managed credit poorly in the past. “Their behavior was so poor that no one will lend them credit,” says Watts.It’s difficult to make assumptions about income, too. “It tends to be lower — and some middle — income,” says Nick Jacobs, spokesman for the National Foundation for Credit Counseling, an umbrella group of local nonprofit credit counseling services. “There are some middle-income people who just haven’t built up enough of a file yet.”

But some very wealthy individuals are also living without credit. “The very wealthy often don’t have credit,” says Linda Sherry, spokesperson for Consumer Action, a D.C.-based advocacy group. “They have no need for it — they pay for things with their checkbooks.”

The real cost of no creditCredit histories were originally developed as financial tools to help lenders (usually for mortgages and credit cards) assess whether consumers would pay their debts. Today, credit histories are being used as a screening tool for everything from jobs to insurance rates. Little, no or poor credit can make it more difficult — and in some cases impossible — to get a home, car or even some jobs.

But the biggest cost is financial. Life costs more when you can’t access credit. It’s also harder to do the things most consumers take for granted, like driving to work or throwing in a load of laundry. Without access to normal credit, people either do without items like cars, washing machines and furniture until they can save enough to pay cash, or they obtain them at higher-than-normal rates. Those who can’t pay cash or talk a lender into taking a chance on them sometimes turn to businesses that charge higher-than-retail prices for furniture and electronics, and lenders who offer high interest rates for payday, car tag loans or auto loans.

And it’s a tossup whether no loan or one with a higher interest rate is the worse option for consumers, says Janet Garkey of the Credit Union National Association for Personal Finance. The difference in the rate on a $100,000, 30-year, fixed-rate mortgage for someone with a 520 (poor) score and a consumer with a 720 (borderline good) is 3.45%, says Garkey. That translates to $235 per month in payments and $85,000 over the life of the loan.

Breaking inLiving with no credit can be severely limiting, but there are ways to get into the credit system. Some lenders “will try to work with you,” says Sweet. “But what it means is much more work for you.” And that could include digging up proof of rental payments, old power bills and the like.

One good option: join a credit union. Because of the relationship that is established, it’s easier to get help accessing traditional credit options — and advice on entering the credit game, says Garkey.

Another option: get a secured credit card to start building up a positive credit history. The way it works: You apply for a card and make a deposit that will be equal to your credit limit. You use the card and pay the monthly bills, and the lender keeps your deposit for the life of the card. If all goes well, the lender may issue you a regular credit card after you’ve established a record of good payment. Then you’ll get your deposit back. Consumers sometimes feel a social stigma about having a secured card, says Arnold. But that’s totally unnecessary, he says. “The only people who know the card is secured is you and your bank,” he says. It reports to the credit bureaus “just like a normal credit card,” he adds.

Another option is to get a relative or very close friend to add you as an authorized user on their credit account in good standing. This takes a while longer to establish a history, but it can be very effective. The account holder can either give you access to the account or not, but as long as that account is kept up to date, it will reflect on your future credit history.

If you have some credit history but not much (known as a “thin file”), you might benefit from a lender using a FICO Expansion score. Scaled like a regular FICO score (from 300 to 850), the formula is designed so that the lender can incorporate additional information that might not be in a traditional credit file. For an Expansion score, Fair Isaac will go to “boutique credit repositories” that may have data not traditionally reported (like the payment record from a book or record club), says Watts. The company might also look at how often you use checks or how often you have to access overdraft protection. In addition, if lenders can obtain additional information (like rental payment history or utility payment history), that can also be factored into the formula.

“It’s going to help the people with no credit and it could also help the people with poor credit,” Garkey says. Curtis Arnold, founder of CardRatings.com, agrees. “I think it’s a positive thing. With rental histories and power bills you’ve proven that you can pay your bills.”

A relatively new addition to the credit-scoring universe is the VantageScore — introduced as a joint effort by Equifax, Experian and TransUnion — which rivals the FICO score but so far is being used by very few lenders. The VantageScore, which ranges from 500 to 990 and includes A to F ratings as well, is being promoted as paying particular attention to “thin” credit files.

People without credit are “a large segment of our society,” says Arnold. “And the risk is that they are not being judged fairly.”

By Dana Dratch, Bankrate.com. Dratch is a free-lance writer based in Atlanta.